SEBI Closing Auction Session: Market wants F&O expiry settlement delinked from cash auction
Market participants are overwhelmingly in favour of one change even before the Securities and Exchange Board of India (SEBI) floats its consultation paper on the Closing Auction Session: delink the settlement of expiring Futures and Options contracts from the cash-market closing auction.
SEBI said on Thursday that it will review settlement price calculations following sharp volatility seen on expiry days.
The consensus across dealing rooms is that CAS itself should stay, but should no longer be used to settle derivatives positions. Participants say a separate mechanism for F&O expiry would allow the cash auction to perform its intended function without having to absorb the impact of large derivatives positions.
Keep CAS, Separate Expiry
“The Closing Auction Session stays, but the likely direction is separation,” said Venkatachalam Shunmugam, Partner at MCQube. “A dedicated closing mechanism for settling Futures and Options positions on expiry is needed, so that one auction is not asked to do two jobs in the same twenty minutes.”
Shunmugam said participation will ultimately determine whether the CAS develops sufficient depth. “A thin book gets deep only when people join it. Retail investors, mutual funds and algorithmic desks have spent a month watching the closing auction from the sidelines. The consultation is the moment to step in.”
Retail Traders Stay Away
The first month of CAS has exposed problems during index rebalancings and weekly expiries, when large order imbalances resulted in sharp index moves.
“We have seen a couple of instances when the market turned highly volatile,” said Chandan Taparia of Motilal Oswal. “The market struggled to absorb MSCI rebalancing in the closing minutes, and Bank Nifty has moved 500 to 600 points during CAS. The regulator realised that liquidity is not happening in the CAS. Without liquidity, it would be very tough to digest the existing system.”
Taparia said retail traders are reluctant to participate because their orders have a lower probability of execution than in continuous trading.
“The question is why should people bid in the CAS when there is a very limited chance they will get the trade. Better to trade in the live market.”
He proposed narrowing the ±3% auction price band and ending options trading at 3:15 pm, allowing expiring contracts to be settled before the cash auction begins.
The Timing Problem
Another concern is the different trading windows for cash and derivatives. Continuous F&O trading runs until 3:40 pm, while the cash market enters its auction phase at 3:15 pm and completes price matching by 3:30–3:35 pm.
That leaves options traders without continuous underlying price discovery during the final part of the derivatives session, making dynamic delta-hedging difficult and potentially contributing to distorted option prices and erratic bid-ask spreads.
The issue is particularly relevant on exchanges where derivatives activity is substantially larger than cash-market turnover.
“SEBI is right in bringing CAS; this is the right global standard,” said another trader. He argued that the problem is not CAS itself but the lack of volume on the BSE.
Saikat Kumar, Partner and Board Member at Red Lions Capital, called SEBI’s planned review a “welcome and measured step.” “The objective should be a settlement methodology that is transparent, representative and resilient. The best approach should ultimately be determined by evidence and market experience,” he said.
Kumar added that it would be premature to attribute all moderation in derivatives activity solely to CAS, noting that volumes are influenced by multiple market factors.
Tracking-Error Risk
The new mechanism also poses challenges for passive funds and mutual funds. Since official Net Asset Values (NAVs) are pegged to the final close, large Market-on-Close (MOC) index orders can remain unexecuted when price bands are breached in an illiquid auction, increasing tracking-error risk.
CAS was introduced in August to replace the traditional 30-minute Volume Weighted Average Price (VWAP) method, with the aim of aligning Indian markets with global exchanges such as the NYSE and reducing the scope for end-of-day VWAP manipulation. But the structure has created what market participants describe as a “tail wagging the dog” problem: a relatively small underlying cash market is being used to settle a derivatives complex with multiples of its notional size.
Extreme Moves, Immediate Enforcement
The first month produced some extreme moves. On monthly derivatives expiry sessions, the BSE Sensex swung more than 2,000 points within minutes during the auction window, while individual stock contracts recorded sharp price dislocations.
Dixon Technologies’ 15,000 Call Option jumped from Rs 2.65 to Rs 104.90 before collapsing to settle at Rs 0.05 on August 25.
SEBI also moved quickly against alleged manipulation. Within weeks of the CAS launch, it passed an interim order barring Copthall Mauritius Investment and Mansi Share and Stock Broking and impounded Rs 3.68 crore in alleged unlawful gains. The action followed alleged manipulative order placement that distorted indicative prices during a Sensex auction on August 13.